"In this game, the market has to keep pitching, but you don't have to swing. You can stand there with the bat on your shoulder for six months until you get a fat pitch."

- Warren Buffett

Interesting chart from John Hussman this week showing Roger Babson warning that the U.S. stock market was overvalued the two previous years leading up to 1929 and then again at the market peak. We know now that it was overvalued in 1927, but it became more overvalued in 1928 and even more in 1929.

People assumed Babson's earlier warnings were incorrect because the market became more irrational in the short term. The market could have easily have gone up in 1930 and 1931 before it met gravity. The question is; would that have made his statement in 1929 that the market was dangerous incorrect?

This is similar to how I have felt talking with people about the U.S. markets over the past few years. In 2012 I felt the market had run too far too fast causing valuations to become extended and dangerous. What has happened over the past two years? The market has risen relentlessly, causing valuations to become far more extended than they were in 2012.

This does not mean the markets must fall now. Just as they could have continued to become more overpriced in 1929, they could easily become more overpriced in 2015, 2016, and beyond. John Maynard Keynes once said "the market can remain irrational a lot longer than you and I can remain solvent."

I personally do not plan on purchasing U.S. stocks until they become inexpensive and throw investors a fat pitch, something I believe will occur again at some point in my lifetime.

Billionaire Carl Icahn tells CNBC that you cannot keep an economy up with the just the Federal Reserve. While he admits it is impossible to pick the exact moment the market will break, he says that on a macro level "something has to give here."

Wednesday, October 8, 2014

The absolute worst case scenario you encounter in the world of finance today is a catastrophic stock price decline. The good news, you are immediately told, is that even if this worst case scenario should improbably occur you must only hold on tight, close your eyes, and purchase more stocks. Everyone that has followed this strategy over the last 80 years in the United States market has done fantastic.

Sounds good, right? You know the people running the casino have no financial advantage by keeping you playing, they only have your best interests at heart.....right?

The following chart shows U.S. stock prices from 1789 to 2014. If you are looking for a big picture, this is it.

What jumps out at me on this chart?

First, you'll notice that if you began purchasing stocks around 1938, or any time over the last 76 years, every major dip in the market recovered almost immediately to go on and make new highs. Everyone that held on, bought on the dips, and was strong through the storm grew richer and richer.

1937 to 2014 (ish) will be written in history as the golden age of the U.S. economy and U.S. financial markets. It became the strongest economy in world history in the 1950's and 1960's and it has held the illusion of wealth for decades beyond by borrowing almost 60 trillion dollars.

What about before 1938? You can see that the 19th century was not as kind.

If you bought stocks in 1837 at the market peak, 60 years lateryour portfolio was underwater. Please read the last sentence again, then imagine talking to a person about "buying the dips" and "stocks always rise in the long run" at the turn of the 19th century.

How about in the early 20th century?

If you bought stocks in 1907, your portfolio was underwater 25 years later.

If you bought stocks in 1929, your portfolio was underwater 25 years later.

Yes, 25 years later, at a time when the United States was a global economic powerhouse. It had real wealth built on a strong currency, savings, business growth and exports.

How about another country? Maybe one where investors experienced almost immediate gains after they bought every dip for 45 straight years. The following chart is the Japanese stock market, which peaked in 1990. 25 years later the market is 60% below its peak, after a massive rally that began in late 2012.

How about real estate? We all know real estate prices always rebound immediately. In the United States there has been only one vivid memory of price declines over the last 80 years, which occurred from 2007 - 2012. Since then, however, prices have come roaring back and some cities have already surpassed their pre-2007 bubble price peaks.

Is it possible that real estate prices could decline, and then keep declining? Here is a chart from Japan's 1990 peak in real estate prices.

The obvious answer to these problems in Japan is someone did not have the courage of Ben Bernanke to step in and save the country with a printing press. Only they did. They increased the monetary base almost 300% from the early 1990's through 2007 with multiple QE programs. This led to 65% declines in housing over that period coupled with a 55% loss in the stock market.

Investors in the United States have been conditioned to believe that when prices of financial assets decline, they will immediately rebound after some short term pain. This is what allows them to be "all-in" the financial markets. What if U.S. stocks, bonds and real estate prices all declined simultaneously and did not immediately recover?

Wait, is it possible that bonds can fall simultaneously alongside stocks? A 33 year bull market in bonds, which is in its final stages today, has conditioned investors to believe this is impossible. Bonds were clobbered in the 1930's, alongside stocks and real estate, when the U.S. had a fundamentally strong economy.

Today the U.S. economy has a fundamentally weak economy. It is a house of cards, smoke and mirrors, a QE mask sprayed on a mountain of toxic debt. The global economy is now counting on the United States to pull it out of the current economic malaise at a time when the U.S. economy is on the brink of falling back into decline.

Germany, the once lone bright spot in Europe, has likely just triple dipped into recession.

Japan has joined them, only their economy is collapsing faster.

China is contending with an enormous real estate bubble combined with banking sector debt that has risen from $10 trillion in 2007 to over $25 trillion today (the entire U.S. banking system is less than $15 trillion in size).

Emerging markets around the world are counting on China's economic growth:

The world entered a global depression in December 2007 which it has not emerged from. The patient was provided an unprecedented dose of morphine stimulus which is now wearing off. Central banks are already "all-in" with bloated balance sheets and interest rates resting at zero. There is no exit, and there is no one coming to the rescue. You cannot solve a structural debt problem in the global economy with more debt and printed money. It only pushes back the pain and intensifies the next crisis.

Portfolio advisors today recommend holding an extremely low level of cash and precious metals as a share of your total portfolio. I recommend you increase those percentages, specifically the cash allocation. Why?

You cannot purchase insurance after the hurricane arrives, and there is a level 5 hurricane approaching.

I came across the interesting chart below today at Business Insider showing that based on the IMF's purchasing power index China has just crossed over the United States as the world's largest economy (GDP).

While the U.S. is still far larger based on nominal GDP, the actual wealth of the economy using a combination of market-exchange terms and purchasing power is now greater in China. 99% of the citizens in the United States are running on a treadmill or walking through quicksand in terms of real wealth, while they are shown a rising stock market every afternoon on the news.

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and but she will never sit down on a cold one either."

- Mark Twain

"It's waiting that helps you as an investor, and a lot of people just can't stand to wait."

- Charlie Munger

"Live as if you were to die tomorrow. Learn as if you were to live forever."

- Gandhi

"One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do. I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I wait for a situation that is like the proverbial shooting fish in a barrel."

- Jim Rogers

"Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

- James Grant

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

- Ben Bernanke, March 2007

"Everything that needs to be said has already been said. But since no one was listening, everything must be said again."

- Andre Gide

"When people are getting richer and richer but they're not actually producing anything, it can't end well."

- Louis CK

"In economics things take longer to happen than you think they will, and then they happen faster than you thought they could."

- Rudiger Dornbusch

"I don't write about what I know. I write to find out what I know."

- Patricia Hampl

"Chains of habit are too light to be felt until they are too heavy to be broken."

- Warren Buffett

"Everyone has a plan until they get punched in the mouth."

- Mike Tyson

"Interest on the debt grows without rain."

- Yiddish Proverb

"You can have comfort, or you can have value. You cannot have both."

- Jim Grant

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

- Warren Buffett

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"Men who can both be right and sit tight are uncommon."

- Jesse Livermore

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

-Ludwig von Mises

"Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe. It's just a matter of the price paid for them."

- Howard Marks

"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

-Mark Twain

"None are more hopelessly enslaved than those that falsely believe they are free."

-Goethe

"The longer the markets disobey basic rules of valuation, the bigger the opportunity for good investors to reap the benefits. Value investing works precisely because markets become dysfunctional at times."

-John Coumarianos

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

-Sir John Templeton

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"People only accept change in necessity and see necessity only in crisis."

-Jean Monnet

Requiring a central bank to print money to increase government's purchasing power invariably ignites a hyperinflationary firestorm. The result through history has been toppled governments and severe threats to societal stability.

- Alan Greenspan

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

- Henry Ford

"Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?"

-Steve Jobs

"I'd be a bum on the street with a tin cup if the markets were always efficient."

-Warren Buffett

"The market can stay irrational longer than the investor can stay solvent."

- Keynes

"While the government struggles to save one crumbling enterprise at the expense of the crumbling of another, it accelerates the process of juggling debts, switching losses, piling loans on loans, mortgaging the future and the future's future. As things grow worse, the government protects itself not by contracting this process, but by expanding it."

-Ayn Rand, 1974

"The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

- F. Scott Fitzgerald

"All our life, so far as it has definite form, is but a mass of habits - practical, emotional, and intellectual - systemically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be."

-William James

"Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

-Charles Mackay

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

- Stephen Hawkings

"Give me control of a nations money supply, and I care not who makes it's laws."

- Amschel Rothchild

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.

- Sigmund Freud

Many of life's failures are people who did not realize how close they were to success when they gave up.